The Politics and the Economics of Stimulus

My lefty critics don't believe me when I say I support the stimulus. But I do, and I advocated it in my book A Failure of Capitalism, completed before the stimulus was enacted. I am a Keynesian, and I have sharply criticized conservative economists who oppose Keynesian deficit spending. I simply do not believe that it is possible to attribute the improvement in the economy to the actual spending of stimulus money through the end of the second quarter, because I believe the actual spending was small and that the significance of the stimulus program is more psychological than (as yet) economic.

I attribute Christina Romer's August 6 speech, and Vice President Biden's speech of September 3 on the first 200 days of the stimulus program, to the political imperative of shorting up public support for the stimulus. Oddly, the program is unpopular, and not only among Republicans. The reason for its unpopularity I believe is the Administration's health care plan. The unfunded and probably unfundable cost of the plan has riveted public attention on the nation's huge deficits. $787 billion in deficit spending obviously adds a lot to the deficit. The stimulus program probably should have been adopted last fall rather than in February of this year, and expedited more vigorously than it has been. Romer has warned in her academic writing (which incidentally I admire) that Keynesian measures for spurring recovery from an economic downturn tend not to be implemented until the downturn has reached its bottom and thus they risk overheating the economy by adding public demand when private demand is again growing. This should worry Romer, although because of the continuing credit crunch, continued stimulus expenditures may not in fact overheat the economy. In the postwar recessions that she discusses (particularly in a 1994 article with David Romer in the NBER Macroeconomics Annual), fiscal recovery measures came on top of monetary measures, namely reducing interest rates. When a nation's banking system is in bad shape, monetary measures lose much of their efficacy. The Federal Reserve has pushed interest rates way down, without stimulating much lending. The economy may well have considerable slack for months or even years to come, in which event stimulus expenditures will not cause inflation.

My criticisms of Christina Romer's August 6 speech (most recently in my blog posting of August 25) continue to draw criticism, most recently (as far as I know) from the economist Menzie D. Chinn, in an August 27 posting on Econbrowser--an excellent blog. Professor Chinn makes a series of criticisms of my argument, starting with saying I have "given up on accusing Dr. Romer of lying about the $40 billion figure." The reference is to her estimate of the tax benefits authorized by the stimulus bill that were granted by the end of the second quarter of this year (June 30). I never accused her of lying about the figure; I do not even question the figure. My point was the difference between authorizing or disbursing money and spending it. No one seems to know how much of the $40 billion was actually received by taxpayers, as opposed to reducing their future tax payments; and of the amount actually received by them, no one seems to know how much they spent rather than saved. These distinctions have eluded Professor Chinn, though I had emphasized them in my August 25 blog posting--the target of his criticisms. He seems to think that it is possible that all the $40 billion took the form of rebates, but as far as I know none of it did. A rebate would be a check to the taxpayer, as distinct from a tax credit. Bush's spring 2008 stimulus package consisted entirely of tax rebates; the Obama stimulus does not.

Professor Chinn says that even if none of the $40 billion in tax relief was actually spent by recipients of the relief in the second quarter, the remaining $60 billion of Romer's "more than $100 billion" was ample to increase GDP that quarter by two percent. But that assumes that all of the $60 billion was spent, and no one seems to know how much was; Chinn assumes it all was, which is false. A neglected point is brought out in an article by Michael Cooper in the September 5 New York Times. The article points out that federal stimulus spending can be nullified by state cutbacks. For example, a federal grant of stimulus money for mass transit has been nullified by reductions in state expenditures on mass transit. The question then becomes what was the consequence of those reductions? Maybe they enabled a state to rescind a tax increase, in which event state taxpayers would have more money in their pockets. And then the questions would be: how long does this process take, and how much of the additional money do the taxpayers spend rather than save?

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Richard Posner is an author and federal appeals court judge. He has written more than 2500 published judicial opinions and continues to teach at the University of Chicago Law School.